Health Savings Accounts (“HSA’s”) are amazing. So much so, we’re doing a multi-part blog series starting with Basic Concepts, to the Sweet Income Spot, to more Advanced Concepts.
I’m also considering turning off the auto-correct my computer does from “hsa” (had to type that twice) to “has” because I type the word so much 😊
What is an HSA?
In simplest terms, HSA’s are a tax-advantaged savings and/or investment account used to pay for qualified medical expenses, with the ability to convert into a retirement-account-like vehicle in your mid-60’s (more on that below). Typically, you contribute to an HSA by having your employer take it out of your paycheck (some companies even have a "match" on HSA's), but they can be contributed to even if you don’t have group health insurance or an HSA through your employer.
Qualifications for an HSA:
1) You are not being claimed as a dependent on someone else's tax return
2) You have a High Deductible Health Insurance Plan ("HDHP"). For 2024, this means your plan must meet both the following criteria:
a) Deductible must be above $1,600 (unless on a family plan, which then becomes $3,200)
b) The out-of-pocket maximum (deductible, coinsurance, etc.) must be less than $8,050 (or $16,100 for family plan)
3) You aren’t enrolled in Medicare (big thing here is to remember that Part A backdates up to 6 months, making you ineligible for HSA contributions, if you enroll in Medicare after you turn Age 65 – tell your parents if they are around this age😊)
4) No other health coverage (which some FSA's fall into - watch the video below to learn if you can contribute to an HSA and FSA at the same time!)
Can I contribute to both an HSA and FSA?
Contribution Limits to an HSA:
The limits are changed each year to properly index with inflation, but for 2024 the contribution limits for those under Age 55 are:
Self-Only: $4,150
Family: $8,300
Note 1: The above limits INCLUDE whatever your employer puts in. This means if you are on a family plan and your employer puts in $1,000, you are limited to contributing $7,300, or you will run into an Excess Contribution situation (i.e. you pay a 6% tax every year on that ineligible amount until it is removed from the HSA).
Note 2: The above limits assume you were eligible (i.e. meet the Qualifications listed above) for the entire tax year! But if you had a change in circumstances such as changing jobs or changing health insurance plans, you may have to dig into the exceptions below!
Exceptions:
1) Last Month Rule: As long as you were on a HDHP on December 1, you are considered eligible for the entire tax year. The caveat though, is there is a ‘testing period’ where you have to remain on a HDHP for the subsequent 12 months (i.e. for the 2024 tax year = December 1, 2024 through December 31, 2025) – failing to remain on a HDHP will subject you to a 10% penalty, and including the ineligible contributions as income on your tax return.
2) Pro-Rata Rule: If you are only going to be on a HDHP for say 7 months out of the year and you don’t want to risk fate with the Last Month Rule, you can simply multiply the annual contribution limit by 7/12 (i.e. $8,300 family plan x 7/12 = $4,841.66). Your eligibility for each month is based on your health insurance coverage status on the first day of the month. This pro-rata rule also applies conceptually to switching between Self-Only coverage to Family coverage (or vice versa) mid-way through the year.
Medical Expenses
The definition of medical expenses eligible to be used from an HSA are very broad. Non-prescription over-the-counter medicine, pregnancy tests, contact lenses, even a vasectomy qualifies! And you can use HSA’s to pay for medical and dental expenses for yourself, your spouse, and your dependents.
Retirement-Account-Like Features
As mentioned earlier, HSA's not only serve as a savings account for medical expenses, but also as an investment account! Just like your 401(K), your HSA provider will have a list of funds you can invest in. And all that investment growth within the HSA is tax-free.
Once you reach age 65, there are no penalties for withdrawing money from your HSA, for any reason! This means you would just have to pay your ordinary income tax rate on the withdrawals ...sounds to me just like a Traditional IRA or 401k! Except even better than a Traditional IRA or 401k, there are no required minimum distributions ("RMD's"). The only downside is if you withdraw HSA funds before you turn 65 AND it's not for a qualified medical expense, the penalty is a hefty 20% (whereas with IRA's and 401(K)'s, the penalty is only 10% for early withdrawals), plus your ordinary income tax rate.
In the world of tax-advantaged accounts, HSA’s stand at the top. When harnessed optimally, they are often touted as a ‘triple-tax’ advantaged account. In our next post, we’ll explore how you can actually elevate HSA’s from a ‘triple-tax advantaged account’ to a ‘quadruple-tax advantaged account’ for the right level of household income.
About the Author
Zack Gutches, CFP®, CPA is a Christian Financial Advisor who provides ongoing fee-only financial planning, investment management, and tax preparation services in Aurora, CO locally and nationwide virtually. True Riches Financial Planning serves clients as a fiduciary at all times and never earns a commission of any kind.
